Question

explain how coase theorem is used to weaken the argument that government policy is not needed to address environmental problems

Answer 1

British American economist Ronald Coase developed the Coase theorem in 1960, and, although not a regulatory framework, it paved the way for incentive-driven, or market-based, regulatory systems. According to the Coase theorem, in the face of market inefficiencies resulting from externalities, private citizens (or firms) are able to negotiate a mutually beneficial, socially desirable solution as long as there are no costs associated with the negotiation process. The result is expected to hold regardless of whether the polluter has the right to pollute or the average affected bystander has a right to a clean environment.

Environmental economics objectively looks at natural resources and environmental issues from a market perspective. In the traditional model, supply (private marginal costs) is equal to demand (social marginal benefits) that create a socially optimal equilibrium. When private marginal costs differ from social marginal benefits, an externality is produced. Transitioning from what an externality looks like graphically, “An externality exists when a person makes a choice that affects other people in a way that is not accounted for in the market price.” [1] These choices are generally based off production and consumption needs by an individual or firm and can be positive or negative. Since individual choices are not accounted for in the market price, the nonexistent natural correction for the market failure creates a loss of Pareto efficiency. However, in 1960, economist Ronald Coase recommended a private solution of to how an individual ought to deal with an externality. The Coase Theorem was praised for its comparatively unconventional approach and led some to believe that it was fundamentally different. This paper will analyze the economic logic and identify implicit moral presuppositions involved in the Coase Theorem that achieve the same socially optimal outcome of other neo-classical environmental economics models.

The key result of the Coase theorem, that the allocation of property rights does not affect the efficient amount of pollution, has limited application. If there are multiple polluters and/or many parties affected by the pollution, the outcome can depend on how property rights are assigned. Similarly, if there are significant transactions costs, such as measurement and enforcement costs, the Coase theorem may not hold. Assume, for example, that two towns are affected by the factory's emissions, one further downstream than the other. Suppose that the town further away from the chemical plant has lower costs associated with cleaning the water. In this case, the amount of compensation the towns would be willing to pay to reduce emissions by any given amount would differ. Thus, the allocation of property rights among the firm and the two towns would affect the outcome of their bargaining.Suppose, instead, that more than one firm is polluting. Determining how much pollution is coming from each firm, along with ensuring that each firm lives up to any agreement, may be difficult and costly. If monitoring costs are high, the Coase theorem may not hold and the allocation of property rights again affects the choice of optimal emissions.The lack of general applicability of the Coase theorem is not an indictment of using market oriented incentives (which usually requires assigning property rights). Most economists believe that market-oriented solutions will lead to the most efficient use of resources because, rather than having the government attempt to estimate preferences, it allows the market mechanism to reveal them.

Property rights are not always assigned because many uses of the environment are considered public goods. A pure public good is one that has two qualities: First, it is impossible or extremely costly to exclude people from the benefits or costs of the good (non-excludability). For example, even if a person does not contribute to cleaning the air, she still cannot be excluded from breathing the cleaner air. Second, the consumption of the good by one person does not diminish the amount of that good available to someone else (non-rivalry). For example, the fact that one person is breathing clean air does not reduce the amount of clean air others breathe. In this case, property rights cannot be assigned because rationing is impossible.While few uses of the environment are pure public goods like air, many have enough features of non-excludability and non-rivalry to make assigning property rights virtually impossible. The functions of the environment that are public goods, such as breathable air and clean water, are summarized by the term environmental quality.Regulating environmental quality is difficult because the government first needs to determine the public's demand for environmental quality before deciding the efficient level of pollution. The free-rider problem that occurs with public goods makes this determination especially difficult. When people cannot be excluded from use, they have an incentive to understate their willingness to pay for environmental quality because they can gamble that others will be willing to pay. Similarly, if they are asked their preferences and know they will not have to pay, people have an incentive to overstate their desire for a given public good. The degree to which free-riding is a problem depends on the size of the non-rival group affected. The larger the group, the greater the free-rider problem. For the purposes of this paper, we will assume that to determine the "true" value of public goods, the government measures the costs of pollution reduction and the benefits of pollution abatement accurately.Using a cost benefit approach, the optimal outcome is where the marginal cost of pollution reduction equals the marginal benefit of pollution abatement.It is important to recognize that the socially optimal level of pollution is generally not zero. Achieving zero pollution would require an extremely low level of production or an extremely high cost of pollution control. In determining the optimal amount of pollution, both the costs to individuals and industry need to be taken into account.